WORD ON THE STREET: People are looking for guidance and comfort to navigate through change and a difficult economic climate. To facilitate economic growth, both nationally and locally, the key lies within community banks and credit unions and their relationship with Main Street America.
But currently, there is a fundamental problem with this fact. The well-being of community-based financial institutions have been overlooked by Congress and U.S. regulators and, thus, came into the recession healthy but are emerging weaker than ever. Large corporations and ‘too big to fail’ banks are producing record profits, while the more prudent community banks and credit unions that largely avoided the subprime mortgage crisis are struggling.
Community-based institutions represent a unique pillar of stability for our economy, acting as a collaborative network that maintains direct ties to the communities they serve. The financial sector may be the ideal industry to stabilize the markets and kick-start the economic engine, and community institutions – as opposed to large banks that consumers no longer trust – can be the drivers of the economic turnaround.
However, there are economies of scale in compliance costs that place substantially more pressure on community banks and credit unions than their larger counterparts, and applying regulations to address the practices of a few institutions will either directly or indirectly impose costs on all. Since the establishment of Troubled Asset Relief Program (TARP), compliance costs have increased dramatically, to the point where organizations are forced to consider how large it has to be to just stay in business. Policy-makers were forced to concentrate on the immediate need of near-term issues, which promoted legislation allowing big banks to get bigger, healthier and more competitive. Unfortunately, the fallout caused community banks and credit unions to be the unintentional victims of this legislation.
Although the language of the new Dodd-Frank Interchange Fee Amendment exempts community-based institutions from regulation, this will hardly be the case. The marketplace, as determined by the Fed, will gravitate to one price, and the interchange rate of community-based institutions will closely align with the government rate. Community-based institutions will have to adjust prices on other offered products and services, such as free checking, and curtail valued service offerings, like debit card rewards programs, to recapture lost revenue caused by a lower interchange fee income stream. Ultimately, it will be the underserved, un-banked and low-income consumers who will be impacted the most.Â
It is naive to think there will not be a trickle-down effect on community banks and credit unions from any of the 240 rule interpretations required in Dodd-Frank, which is simply not designed to promote the health of community institutions, but instead cements ‘too big to fail.’
Equally important, there has been no TARP-style legislative support provided to these organizations, which also suffer because they are less diverse in their product portfolios and the markets they serve than their big bank cousins. So these organizations – which always prudently lent to small businesses at higher rates than the larger banks and are sticking to their bread and butter of collecting deposits and lending out to their geographic area – are suffering without equal intervention.
Where we see local economies taking the hardest hits, we see the supporting community banks and credit unions struggling, being acquired or failing altogether. And there is no legislative action helping these organizations.Â
Similar to what has been seen during the aftermath of TARP, the financial industry will grow smaller and more polarized. So far in 2010, there have been 149 bank failures, which is nine more than in 2009. Also, there have been only three new credit union charters granted this year, while there have been 114 mergers among National Credit Union Share Insurance Fund-insured cooperatives.
Due to the mistakes of large banks, community-based financial institutions are no longer able to do what they do best: lend to small businesses, one loan at a time, and hold those loans to maturity. Small business accounts for more than 50% of the nation's workforce, making it a vital cog in economic recovery.
But with community institutions catching the post-crisis shrapnel, it looks grim for small business, pointing to a slow recovery for the country as a whole. In the next three to five years, 2,500 community banks will disappear, and 1,000 to 1,500 credit unions will close or consolidate if their costs do not come down and if their local economies do not recover quickly enough. Just as critical, barrier to entry for these smaller competitors have increased tremendously. The Federal Deposit Insurance Corp. approved 1,300 bank applications during the decade, but only three so far this year!
It is clear that unintended consequences of financial legislation are making it harder for community banks and credit unions – the lubricant of local economies – to serve their communities. Community banks and credit unions largely work and live in the neighborhoods they serve, building close relationships.
The very survival of community banks and credit unions is being put into question, which risks the overall health and survival of Main Street America. Community banks and credit unions need to claim their position as the pillar of their local economy, driving economic growth.
The leaders of community banks and credit unions must recognize that what we are experiencing is a moment of clarity for the value of community banks and credit unions, and this message must be communicated. Community banks and credit unions must differentiate themselves from big banks and make their inherent differences obvious to customers. Qualities such as agility, flexibility and drive are important, but above all else, today's leaders must anticipate change and be well prepared for what that change may bring. Now is the time to drive innovation, lower costs and prove that community-based financial institutions can deliver economic growth.
Louis Hernandez Jr. is the author of the new book "Too Small to Fail: How the Financial Crisis Changed the World's Perceptions" and chairman and CEO of Open Solutions Inc., based in Glastonbury, Conn. He can be reached at (800) 226-5674.